Special Drawing Rights (SDR) | Definition | Uses | Criticism

Special Drawing Rights (SDR) represents the amount disbursed by IMF to its member countries for meeting their balance of payment deficits or other contingencies.

Special drawing rights

What are SDRs, to whom are they available?

Special Drawing Rights (SDRs) are international units of account in which the official accounts of the International Monetary Fund (IMF) are kept. SDR facility is extended only to member countries of the IMF. They are not available to private banks or commercial houses. SDRs are used for book entries only by the central Banks of different countries. SDR allocations are entered on the credit side of the country and the debtor country transfers SDRs to the creditor country.

SDRs may be freely transferred by an agreement between participants in transactions and operations include purchase and sale of SDRs. SDR has also been used as a currency peg.

When was Special Drawing Rights established?

Special Drawing Rights (SDRs) were established through the First Amendment to the Fund Articles Agreement in 1969.

How were SDRs calculated?

Till December 1971, a unit of SDR was linked to 0.88867 gram of gold and was equivalent to US one dollar. After 1973, the value of SDR was calculated each day on the basis of a basket of 16 most widely used currencies of the member countries of the fund. Each country is assigned a weight in the basket in accordance with its importance in international trade.

SDR as an International Unit of Account:

With the second amendment to the Fund Articles of Agreement in 1978, the SDR became an international unit of account. In January 1981, the number of currencies in the basket was reduced to five. They are US dollar, German Deutsche Mark, the British Pound, the French Franc and the Japanese Yen. With effect from January I, 1986 the present currency composition and the weighing pattern of the SDR is revised every five years. Weights are revised on the basis of the values of the exports of goods and services and the balances of their currencies held by other members. By October 1, 1997, the value of one SDR was equal to 1.035610 US dollars.

Valuation history of SDR:

The Value of SDR changes everyday with the exchange rates. The following table show SDR valuation history of Deutsche mark, French franc, Japanese yen, Pound sterling and United States Dollar right from the year 1984 till 2015.

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Uses of Special Drawing Rights

SDR is an international unit of account which is held in the Fund’s Special Drawing Account. The quotas of all currencies in the Fund General Account are valued in terms of SDR. SDRs are used as a means of payment towards balance of payment deficits. The uses of SDR may be discussed as follows:

Transactions with designation:

A member country which faces deficits in balance of payments and requires foreign currency approaches the IMF. On the application of the needy.country, the IMF designates a participating country with strong balance of payments in the SDR scheme. It provides its currency in exchange of SDR to the participant which requires its currency. The currency involved in the exchange may belong either to the designated country or to some other countries. The lending countries accept SDRs in this fashion till their holdings are less than three times their total allocation.

The IMF acts like a clearing house between the Central Banks of the participating countries. All adjustments in BOP disequilibrium are effected through book entries. The operation of SDR may be understood better by a simple illustration.

Suppose that there are three countries, namely India, UK and USA, participating in the Special Drawing rights scheme. The IMF creates SDR amounting to SDR 10,000 million. It is further supposed that the IMF allocates quota to India, UK and USA as SDR 1000 million, SDR6000 million and SDR 3000 million respectively. India has deficit with U.K to the tune of 1000 million dollar. Now, India approaches the IMF for conversion of its SDR holding into the UK holding. The IMF will request the U.K to accept SDR 100 million from India in exchange of 1000 million of UK. When U.K confirms its acceptance, the transaction becomes complete. The results of the transaction are — India’s holding nil, U.K 7000 and U.S.A. 3000, totaling SDR10,000 million.

Transaction with General Account:

Special drawing rights are used in all transactions with the General Account of the Fund. Participants pay charges in SDRs for the use of the fund resources. They also repurchase their own currency from it.

Transactions by agreement:

The IMF allows sales of SDR for currency by agreement with another participant. Besides World Bank and its associates, agencies like Bank of International Settlements, the African Development Banks, the Arab Monetary Fund, Nordic Investment Bank, etc., may acquire and use SDR in transactions by agreement.

Criticisms against Special Drawing Rights Scheme

The IMF is criticized in the following respects

Discriminatory approach:

The IMF resources are mobilized from the contributions of the member countries. The Special drawing rights provided by the IMF to its members is based on their subscription quota. As the shares of developed countries are higher, the major portion of SDRs is available to them. The share of the less developed countries is comparatively lower. So, the IMF restricts the borrowing capacity of less developed countries.

Inequitable distribution of development finance:

The need for development finance is keenly felt in developing countries. They suffer from chronic BOP deficits, external debt burden, shortage of domestic capital, internal inflation, limited access to private banking and capital markets, variability in export earnings etc., have increased the need for liquidity on the part of developing countries. In this context, it becomes necessary to create more Special drawing rights for less developed countries. But the present SDRs are not need based and the distribution system of SDR is not equitable.

In February 1983, the Brandt commission made the following recommendations:

  • The special Drawing rights allocation should be substantial by paying particular attention to the needs of the developing countries.
  • The IMF quota should be doubled.
  • Developing countries should be supported with enlargement and reform of the General Agreement to Borrow (GAB).
  • Borrowing &om central banks and borrowing from capital markets should be increased.
  • There could be an enlargement and improvement of the compensatory finance facility.

Rescue measure for dollar crisis:

It is criticized that SDR scheme was introduced for an in-genuine purpose. The scheme was put into force at a time when the U.S dollar was under devaluation. It did not take care of better liquidity conditions and financial accommodations for less developed countries. This scheme was intended to save only the dollar crisis. Subsequently, the linkage of SDR value with the basket of world’s major currency was again intended to safeguard the U.S dollar.

Rate of interest on SDR borrowing:

The rate of interest on SDR borrowing was 1.5 per cent upto June 30, 1974. It was 5 per cent between July 1974 and July 1975. This low rate of interest does not attract surplus countries to accumulate the SDRs.

SDR is only a temporary remedy:

Borrowing funds from financing facilities other than SDR is subject to conditional clauses. They are under pressure to adopt specified measures for correcting the BOP deficit. But SDR facility helps deficit countries overcome their deficits without offering corrective measures to offset balance of payments deficit.